Question

What effect does Irrational behavior among investors have on efficient market?

What is the eventual result for Irrational Investors?

Answer 1

‟.Efficient Market Hypothesis asserts that the investor‟s rational attitude is assumed in all investing actions. Investors may sometimes act with a view to achieve easy and quick profits. When they do not act rationally and their investing decisions are random, equilibrium prices deviate. This is a provisional and short-term deviation since irrational actions are counterbalanced with each other. In effect, the actions taken by irrational investors are offset on account of the fact that there is no communication between investors and their transactions arenot interdependent. In addition, due to the fact that irrational investors proceed to overpriced or underpriced investments, they seem to achieve lower returns than rational investors; thus, they are bound to lose money, their assets are likely to diminish, and, consequently, their status in the stock market will diminish, as well (Spyrou, 2003). On the other hand, the involvement of rational investors in arbitrage incurs price equilibrium and efficiency, which implies that markets continue to be efficient, and, therefore, profit maximizing. In terms of EMH, despite the fact that all investors do not act rationally, markets are always rational and efficient. To conclude the discussion on Efficient Market Hypothesis, it is also worth noting that the Hypothesis, apart from the stock market, has expanded to include further areas of financial activity, such as efficiency of funding, efficiency of human resources, prediction, dividends and portfolio construction.

Behaviorists will argue that investors often behave irrationally, producing inefficient markets and mispriced securities—not to mention opportunities to make money.

That may be true for an instant, but consistently uncovering these inefficiencies is a challenge. Questions remain over whether these behavioral finance theories can be used to manage your money effectively and economically. That said, investors can be their own worst enemies. Trying to out-guess the market doesn't pay off over the long term. In fact, it often results in quirky, irrational behavior, not to mention a dent in financial wealth.